7 Questions to Ask Yourself Before Taking Out a Short-Term Loan to Fund Your Home Improvements
By: John | Date Posted: September 20, 2022
Homeowners must make repairs or total improvements to their property to retain its value and make the space more livable. However, home improvements, DIY or otherwise, aren’t cheap. For this reason, homeowners will take out a short-term loan to fund their renovation projects.
While many positives come with a short-term loan, they aren’t for everyone.
Here are 7 questions you should ask before getting a short-term loan for your next home renovation.
What are the Advantages/Disadvantages of Short-Term Loans?
Before getting a short-term loan, you have to ask yourself why you’re choosing this option in the first place. Short-term loans are easier to acquire, don’t incur as much interest, and allow the borrower to acquire funds more quickly. The loan’s credit requirements are also less stringent.
However, short-term loans can be disastrous for your credit if the lender pulls a hard inquiry or you miss multiple payments. It’s easier to fall into a debt trap if you take out many high-interest short-term loans, as you’ll likely need new loans to make payments or refinance the old loan.
What are Short-Term Loan Options Available?
Homeowners and real estate investors have plenty of short-term loan options to explore. Some options may not be applicable if you’re planning to live in the house or don’t own a business.
A short-term personal or installment loan is available to homeowners and investors. Personal loans are often the best way to receive a large sum if you have great credit. The money is often wired to the borrower’s bank account in minutes, especially if you complete an application online and don’t need to offer up collateral.
While this short-term option is actually a cash advance, it still functions as a short-term loan. The lender will still loan the amount needed by the borrower, but the borrower will make loan payments by allowing the lender access to their credit facility. The lender takes a percentage of the borrower’s proceeds every time a customer purchases until the loan is paid off.
A payday loan is a short-term emergency loan that’s very easy to obtain. The borrower must pay the loan back in full on their next payday, and the interest is often very high. Repayments are pulled from the borrower’s bank account.
A line of credit is similar to a credit card but has a lower interest rate. Monthly payments vary based on how much you borrow, and you can make payments yourself from a bank app. Most lines of credit are only available if you have good credit.
This loan is used by a business’s accounts receivables and utilizes invoices that are unpaid by customers. Construction companies may use this loan type if you buy or rent equipment. These loans are optimal for large-scale projects.
The short-term loan option you’ll choose will depend on the amount of money you’ll need and how quickly you’ll need it. For example, a sudden plumbing problem will need your immediate attention, making a payday or same-day personal loan a great option if you’re low on funds.
On the other hand, lines of credit are perfect for consistent borrowing, commonly found with long-term projects. For example, basement renovations or building a detached garage.
How Long Will it Take to Pay Back the Loan?
Paying back a short-term loan can be tough, as most lenders expect total repayment in under a year. The average short-term loan repayment schedule ranges from six to 18 months. While you’ll incur more interest with an 18-month loan, you’re less likely to default and stay in debt.
Can You Comfortably Afford the Repayments?
Short-term loans are perfect if you want to support a temporary personal or business capital need. However, they have to be paid off quickly (and in full), making your repayment schedule short and your minimum payments high compared to long-term loans.
More money isn’t always better, especially when it comes to a short-term loan. The more you borrow, the more you’ll have to pay back, so determine the exact amount you need for your project. As a rule, don’t spend more than 35% to 43% on debt to manage your payments.
Does Your Loan Come With a One-Time Fee?
Some short-term loan lenders will charge a sign-up or origination fee, but it isn’t common. If the lender does request an origination fee, it’ll usually be 1% to 5% of the total loan amount. For example, a $5,000 loan with a 5% origination fee will leave the borrower with $4,750 to spend.
Will Your Credit Affect the Loan’s Interest Rate?
90% of the time, the answer to this question will be “yes” unless the loan amount is small or you’re putting up collateral. If the short-term loan option requires a credit check, you’ll want to score between 740-850 to receive the lowest interest rate possible.
What Type of Home Renovation Project are you Completing?
Since short-term loans require prompt repayment, you’ll want to get your money’s worth. The average cost to remodel a house ranges from $19,800 to $73,200, but renovations focusing on the bathroom, kitchen, basement, and attic will give you the highest return if you sell.
If you’re a flipper, you may rely on a quick return, so place your focus on projects that bring the most value to the home. Even if you plan on staying in your house for a while, it’s still a good idea to accurately price the materials you need to ensure you don’t underspend or overspend.
If you’re a homeowner and don’t think a short-term loan is a right option, consider a home equity or long-term personal loan instead. A home equity loan turns your home’s equity into a line of credit, and a long-term personal loan offers a significantly longer repayment period.
Thank you for reading!